Federation Report Final Draft

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Sustainability of Microfinance Self HelpGroups in India: Would Federating Help?

Ajai Nair, Graduate StudentWoodrow Wilson School of Public and International Affairs

Princeton University

Abstract

Self Help Group (SHG) banking is the primary mode of microfinance in India

today, reaching over six million families. In spite of its considerable outreach, successfulsavings mobilization and high repayment rates, as with most other microfinance models,

the financial viability of SHG banking has not been clear. SHG federations attempt to

provide financial viability and sustainability to SHG banking. This study explores themerits of federating and finds that SHG federations create economies of scale, reduce

promotional and transaction costs, enable provision of value added services and

increase empowerment of the poor.


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Acknowledgements

This study was done for the South Asia Region Finance andPrivate Sector Development Unit of the World Bank. The support ofSophie Sirtaine at the World Bank, who helped design the study andtook time to read through the different drafts, is gratefullyacknowledged. I thank all the organizations visited and individualsinterviewed for their cooperation, and participants of the various fora

at which the initial drafts were presented for their valuable comments.I also thank Marilou, Director, South Asia Region Finance and PrivateSector Development Unit and other members of the unit for theirsupport during the course of the study. Finally, I thank Maya Tudor andKathryn Gwatkin, my classmates at the Woodrow Wilson School, whoread through the final draft and suggested changes that make thereport read better.

Currency Equivalents (Exchange Rate Effective June 2001)

Currency Unit = Rupees (Rs.)US$ = Rs.47.00

Definitions

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Block: Sub-district geographical unit that is the basis fordevelopment planning and implementation in India.

Mandal: Sub-district geographical unit unique to Andhra Pradeshthat is both a revenue and development planning unit, butsmaller in size than a Block.

Promotion: Process of NGOs or government agencies extendingsupport financial and non-financial for formation anddevelopment of SHGs and SHG federations. The wordspromotional cost and promoter organizations are also usedin this context.

Abbreviations

APDPIP Andhra Pradesh District Poverty Initiatives ProjectACCU Association of Asian Confederation of Credit UnionsCDA Cluster Development AssociationCDC Community Development CorporationCDCU Community Development Credit UnionCDF Cooperative Development FoundationCIG Common Interest GroupDHAN Development of Humane ActionGCMMF Gujarat Cooperative Milk Marketing FederationHDFC Housing Development Finance CorporationHUDCO Housing and Urban Development Corporation

IRDP Integrated Rural Development ProgramKVK Kurinji Vattara KalanjiumMACS Mutually Aided Cooperative SocietyMFO Microfinance OrganizationMYRADA Mysore Resettlement and Development AgencyNABARD National Bank for Agriculture and Rural DevelopmentNGO Non-government OrganizationNHG Neighborhood GroupPRA Participatory Rural AppraisalPRADAN Professional Assistance for Development ActionRBI Reserve Bank of India

ROSCA Rotational Savings and Credit AssociationSAPAP South Asia Poverty Alleviation ProjectSERP Society for Elimination of Rural PovertySEWA Self Employed Women AssociationSHG Self Help GroupSGSY Swarnajayanthi Gram Swarozgar YojanaSIDBI Small Industries Development Bank of IndiaSIFFS South Indian Federation of Fishermen Societies

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SMMS Sanghamitra Mandala Mahila SamakhyaSPMS Sri Padmavathy Abyudaya SangamSVAWTC Sri Viswabharati Association of Womens ThriftCooperativesTC Thrift Cooperative

UNDP United Nations Development ProgramVO Village OrganizationWOCCU World Council of Credit UnionsWWF Working Women Federation

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Table of Contents

Executive Summary5

1.0 Introduction9

2.0 The Current Study14

3.0 Services Offered And Functions Performed

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4.0 Benefits Of Federating20

5.0 Financial Analysis24

6.0 Issues / Challenges: Internal28

7.0 Issues / Challenges: External31

8.0 Conclusion34

Appendix 1: Financial Analysis Of Selected Federations 35

A. Shadow PricesB. Financial Analysis Of The Federations: KVK

i. Actual Pricesii. Profitability Of The Federationiii. Profitability Of The SHGs

C. Financial Analysis Of The Federations: SPMSi. Actual Pricesii. Profitability Of The Federation

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iii. Profitability Of The SHGs

Appendix 2: Organizational Structure And Systems Of The SelectedFederations 38

Appendix 3: Profiles Of The Promoter Agencies45

Appendix 4: Organizations Visited And Individuals Interviewed47

Bibliography48

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Executive Summary

Self Help Group (SHG) based microfinance combines thestrengths of Rotational Savings and Credit Associations (ROSCAs) andformal financial institutions. They are similar to ROSCAs in being

membership and savings based. Unlike ROSCAs, however, SHGsreceive loans from formal banking institutions to supplement theirresources, are much smaller membership is less than 20, and arepromoted exclusively among the poor by different promoterorganizations. Some promoter organizations have also federated theSHGs formed by them into SHG federations. These federations vary insize, their legal characters and the range of functions they perform.

SHGs are now the main suppliers of microfinance in India. Thenumber of SHGs has been estimated to be over 400,000, with anoutreach of over six million families. Women make up around 90% of

the membership. As of March 2001, 263,825 SHGs had receivedRs.4.81 billion (US$102.34 million) as loans under an innovativeprogram of the National Bank for Agriculture and Rural Development(NABARD) that links the SHGs and the formal banking system. The on-time repayment rate on these loans is over 95%. The savingsaccumulated in the SHGs that have received loans under this programis estimated to be over Rs.5 billion (US$106.38 million).

In spite of their dominance as providers of microfinance, thefinancial viability and organizational sustainability of SHGs has been inquestion because of its costs being subsidized by the promoter

organizations, the subsidy in loans they receive from banks, and itsorganizational characteristics of small size and predominantly poor andilliterate membership. SHG federations attempt to address many ofthese issues, and this study focuses on the potential of the SHGfederations for making SHGs sustainable. The analysis is based oncase studies of three SHG federations, and a thrift cooperativefederation. The cooperative federation is included as a comparativecase since it is another type of member-based model of microfinancethat has also adopted the federation model. The specific objectives ofthe study were to:

a) Identify the services provided by the selected federations,b) Analyze the benefits of federating,c) Assess the financial viability of the federations andestimate the cost of promoting them,d) Identify the constraints involved in federating SHGs, ande) Recommend strategies to strengthen the federations.

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The study identified a variety of services are available to the SHGmembers of the federations in question. The SHGs provide somedirectly, while the federations provide others. SHGs primarily providesavings and credit facilities. Multiple savings and loan products areprovided, and there is no lower limit on amounts that can be saved.

Members monthly savings range from Rs.25 (US$0.53) to Rs.250(US$5.30) per month. Loans range from very small loans of Rs.100(US$2.13) to large housing loans of Rs.40000 (US$851). By contrast,federations provide financial services such as insurance (human andlivestock) and non-financial ones such as healthcare, education andlivestock care. The primary role of the federations, however, is inproviding support services to the SHGs that contribute to itssustainability, rather than in providing direct services to individuals.

Federations provide an organizational identity to SHGs that,while crucial for sustainability, is difficult for small organizations such

as the SHGs to develop. Federating helps SHGs realize benefits of alarger organization, without losing the advantages of smallorganization. The study identifies the following benefits to the SHGsfrom federating:

a) By creating economies of scale, federations make it possiblefor essential services such as accounting, audit, conflictresolution and performance monitoring to be made available toSHGs. They also contribute to capacity building of SHGS throughfacilitating planning and review processes, and mutual learningevents. In the absence of federations, many of these services are

provided by promotional agencies, an inherently unsustainablemechanism.

b) Federations reduce transaction costs of financial institutions,such as banks and insurance companies that have business withthe SHGs, and the SHGs themselves. For the financialinstitutions, they reduce the cost of dealing with a large numberof small groups; sometimes directly by acting as intermediaryorganizations and at other times by acting as a social collateral.They reduce costs of SHGs by providing a mechanism for costsharing.

c) Federations reduce default rates at all levels from SHGmembers to SHGs, and from SHGs to banks by improvingmonitoring, and providing both positive and punitive incentives.In the long run, the reduced transaction costs and improvedrepayment rates should have a positive impact on the lendingrates to SHGs

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d) Federations provide certain value-added services.The valueadded financial services include special loan products such ashousing loans and insurance for members and livestock. Non-financial services include primary education, health-care,livestock care and technical support for house construction.

e) Federations reduce the cost of promoting new SHGs becauseof their information advantage, low staff costs, and voluntarytime offered by SHG office-holders for forming new SHGs. Thisenhances the replicability and sustainability of the model.

f) Finally, federating enhances the empowerment of the poorbydeveloping local human capital. Federations provide opportunityfor SHG leaders to increase their capacities as they takeleadership positions in the federations, and develop the abilitiesof local youth recruited as staff. Federations also contribute to

empowerment by exposing SHG leaders to diverse organizationsand social institutions.

The financial viability analysis of two SHG federations revealsthat the cost coverage of both federations has improved in the lastthree years. Currently, one has achieved 108% operational self-sufficiency while the other covers 91% of its operational costs.1 Whenoperational self-sufficiency of SHGs is estimated, it is 110% and 91%respectively, indicating that the self-sufficiency at the federation levelis not come at the expense of self-sufficiency at the SHG level.Financial self-sufficiency of the SHGs in the two federations is

estimated to be 104% and 90% respectively. The marginal differencebetween operational self-sufficiency and financial self-sufficiencyindicates very low financial subsidies of SHGs, a feature significantlydifferent from most microfinance organizations. The thrift-cooperativefederation is 100% operationally and financially self-sufficient as itdoes not receive any external funds and the support from promotionalagency is minimal compared to the SHG federations. Promotional costis estimated for one of the SHG federations and was Rs.1.57 million(US$33404) till date. The promotional agency expects the finalpromotional cost for this federation (at the end of financial year 2001-02, when they plan to cease support) to be Rs.1.77 million (US$

37,659).

1 The definitions of operational self-sufficiency and financial self-sufficiency used here are a modified version of thoseused by the Consultative Group to Assist the Poorest (CGAP) at the World Bank. Operational self-sufficiency defined

as the ratio of all operational costs of the organization (administrative, including those borne by the promotional agency

and actual cost of resources) to operational income. Financial self-sufficiency is defined as the ratio of adjusted

operational costs (adjustment made for inflation and subsidized cost of funds) to operational income.

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The constraints and challenges facing SHG federations can bedivided into two categories internal factors that related to the SHGsfederations, and external ones that relate to the other stakeholders.The internal factors include:

a) Initial capacity for self-governance is low since most SHGmembers and leaders have no earlier experience in organizedactivities. This is so since there are few opportunities available forthe poor and women to get involved in such activities. Thisnecessitates significant investment in developing governancecapacity.

b) The federations have difficulty in attracting high qualitymanagers since they either lack sufficient social identity.Thecurrent solution, promoter organization placing their staff asmanagers or recruiting managers on contract, raises the issue ofdual accountability the managers have to be accountable to both

the promoter organization and the federation.c) The organizational systems and processes of the federations

need to be improved to keep pace with the increasing volume oftransactions and variety of services offered.

d) Accountability in a membership-based organization is enhanced ifmembers relate the payments they make to the servicesthey receive. The complex cost structure of federations performinga wide range of functions constrains this understanding, however.Generating income through direct payments such as fee for specificservices or general service charges as a proportion of profits orbusiness volume is an innovative attempt to make the federations

more accountable to the SHGs.e) All the SHG federations are also involved in non-financial activities.

While diversification is justifiable given the needs of the membersand the larger goal of poverty alleviation, the federations need toensure that they establish microfinance as their corecompetency before diversifying.

The external factors that affect the development of SHGfederations concern the promoter organizations, financial institutionsand the legal environment. They include the following:

a) The organizational character of SHGs is not sufficiently clearto all stakeholders. The financial institutions perceive SHGs asmeans to reduce their cost of lending to the poor, and thegovernment sees them as a new means to disburse subsidizedfunds. In contrast, the stakeholders have to see SHGs asintermediary organizations that while, being small in size, requiresystems and processes similar to that in any other organization, if

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they are to be sustainable. Recognizing this is crucial inappreciating the role played by SHG federations.

b) NABARD has been focusing on increasing outreach of the SHG-BankLinkage program. While this was justified till very recently when theoutreach was limited, the rapid increase in the last two years

necessitate that it should instead shift its focus to thesustainability of SHGs.c) There are very few promoter organizations with the capacity

to replicate successful models of SHG federations. Thisnecessitates significant investment in organizational capacitybuilding of existing NGOs, and if needed, new organizations shouldbe promoted for this purpose.

d) A suitable legal framework is lacking for SHG federations.The options offered by the Mutually Aided Cooperative Societies(MACS) Act, a new law recently enacted in seven states of thecountry, should be explored further to see if they can be used in the

current form or an amended form.

This study concludes that SHG federations make SHGs financiallyviable, and provide other benefits that would contribute to SHG-basedmicrofinance becoming a sustainable financial system. Furthermore,SHG federations contribute to the potential of microfinance as apoverty reduction tool by reducing the vulnerability of poorcommunities, and empowering them. Though currently in an infantstage, SHG federations have the potential to become communityorganizations that not only provide a wide range of services to thecommunity, and are accountable to the community. The study

recommends that further research be conducted on a variety of areasrelated to the promotion and performance of federations so as tocreate better understanding of the model among all stakeholders inmicrofinance. The study also identifies the following specific rolespromotional, regulatory agencies and other actors can play in helpingSHG federations achieve their potential.

1. Shifting focus to viability and sustainability of SHGs fromthat of increasing outreach,

2. Expanding the knowledge base concerning the role ofSHGs and SHG federations,

3. Increasing investment in capacity building of SHGfederations and SHG promotional agencies, and

4. Developing a suitable legal framework for SHGfederations.

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1.0 Introduction

In the last two decades, many Micro-Finance Organizations2 wereable to reach significant number of poor, provide them credit atunsubsidized interest rates, and have relatively low default rates on

these loans. Given the critical role of credit markets in economicdevelopment, this led to microfinance being seen as a panacea forpoverty. In addition, microfinance has been seen as empowering sincea large segment of microfinance clients are women. Of late however,the initial euphoria has given way to the recognition that credit is onlyone of the many services the poor need to increase their incomes, andincreased income itself is not sufficient to eradicate poverty. AmartyaSen convincingly argued that poverty is not merely insufficient income,but rather the absence of a wide range of capabilities, includingsecurity and ability to participate in economic and political systems.3

Recognizing this, the World Banks World Development Report

2000/2001 identifies three priority areas for efforts to address poverty:promoting economic opportunity, facilitating empowerment andenhancing security4.

This study examines an innovative model of microfinance thatincorporates all the three areas identified by the World DevelopmentReport 2000/2001 for poverty reduction. This model, federations of SelfHelp Groups (SHGs), extends the unique features of SHG-basedmicrofinance, and contributes to factors that improve the sustainabilityof SHGs. Federations increase the economic opportunity offered by theSHGs, expands empowerment through leadership building, and

addresses the component of security through insurance services. Incontrast to conventional microfinance, which is NGO-based andoperates independent of mainstream institutions, SHGs and SHGfederations are membership-based organizations, and collaborate withcommercial banks and government agencies.

The report is laid out as follows. Section One looks atmembership-based microfinance models in India, and federations ofmembership-based organizations. Section Two spells out the objectivesof the study, and gives brief profiles of the federations studied. SectionThree describes the services provided by the federations. Section Fouranalyzes the benefits of federating, and Section Five presents theresults of financial analysis conducted for two federations. Section Six

2 This paper uses the terminology of microfinance organizations (MFOs) instead of the more commonly

used microfinance institutions (MFIs) since organizations better describe the diverse type of entities

involved in microfinance.3 Sen, Amartya, 2000,Development as Freedom, Anchor Books, New York.4World Bank, 2001,World Development Report 2000/2001, The World Bank,Washington DC.

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and Seven identify issues related to the functioning and promotion ofSHG federations. Finally, Section Eight consolidates the findings of thestudy and identifies areas for further study.

1.1 Membership Based Microfinance Models In India

a) Self Help Groups (SHGs)

The SHG-based microfinance is the main form of microfinance inIndia. This unique approach combines the strengths of traditionalRotational Savings and Credit Associations (ROSCAs) with those offormal financial institutions. In addition to providing savings and creditfacilities to members from their own funds, SHGs supplement theirresources with loans from formal banking institutions. They also differfrom ROSCAs in being smaller (SHGs have 15-20 members), in notbeing constituted for a specific time period, and in their being

promoted exclusively among the poor by an external agency.

SHGs were initially promoted by some NGOs in response to thefailure of formal banking institutions to reach Indias poor. The ideawas based on the prevalence of informal saving and credit groups ROSCAs, temple funds, chit funds, etc. in villages that enabled peopleto pool their money and lend it out to each other. The innovation ofSHGs was in forming groups exclusively of the poor, having smallgroup size (to facilitate interaction and understanding) and convincingformal banks to lend to them. The number of SHGs currently inexistence is estimated to be around 400,0005. Since the average

membership is around 15, SHGs reach over six million families.Estimates of savings in SHGs are not available, but by conservativeapproximation they exceed Rs.5 billion (US$106.38 million).6

The SHG-Bank Linkage program of National Bank for Agricultureand Rural Development (NABARD) allows the SHGs to obtain loansfrom formal banking institutions. Under this program, commercial,rural and cooperative banks lend to SHGs, and NABARD refinancesthese loans at a subsidized interest rate. The programs main claim tosuccess has been repayment rates of over 95% compared to other

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263,825 SHGs have been financed by NABARD. SHGs have also accessed finance fromother apex development banks in India such as SIDBI, RMK, HDFC as well as privatefinancial agencies such as Basix. According to NABARD guidelines, SHGs must be in existence for six

months before they can be extended loans. In practice, however, it takes at least one year before SHGs

access loans from banks. The estimate is based on these facts, and the trend in the number of SHGs

financed by NABARD over the last two years.6NABARD guidelines for its SHG-Bank linkage program recommends that banks start lending with a ratioof 1:1 or 1:2 (loan to savings) and may increase it to 4:1. Only around 20,000 have receivedloans more than once. Cumulative lending under the program is Rs.4.81 billion(US$102.3 million)

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poverty lending programs that have had repayment rates of less than50%. The program, started in 1992 as a pilot project and upgraded to aregular banking program in 1996, has expanded rapidly in the last twoyears.

As of March 2001, 263,825 SHGs had received Rs.4.81 billion(US$102.34 million) under this program. NABARD plans to finance onemillion SHGs through this program by 2008, reaching approximates 75million poor7. Recently, a Microfinance Development Fund wasestablished at NABARD with a start up fund of Rs.1 billion (US$21.28million) using contributions from the Reserve Bank of India, NABARDand other commercial banks.

However, the growth of the program was slow during the initialyears for many reasons. The program is not mandatory like many othersubsidized lending programs supported by the government. The

program requires multiple actors promoter organizations to form theSHGs, the SHGs themselves and bankers to finance them. Thepromotional process has been slow because of the paucity of capableorganizations and insufficient funds. Even after significant number ofgroups had been formed, and their membership and leadershipsufficiently educated, lending to the SHGs was hampered by the novellending methodology. In contrast to the individual and activity basedlending that the bankers involved in, SHG-lending is organization-based. In addition to the necessary criteria of having poormembership, lending is to be based on adherence to strongorganizational practices such as proper maintenance of accounts,

regular group meetings and good repayment performance. Banks havealso been hesitant to lend to SHGs because the loans are to beextended without any collateral, and SHGs are informal organizationsthat do not have body corporate status, and hence cannot be sued incase of default. 8

On the other hand, program growth has been faster in the lasttwo years due to various factors. First, the natural pace of promotion ofSHGs has increased. NABARDs training programs have also resulted inmany bank officers trying out the program. The adoption by thecentral government of the SHG concept as its primary anti-poverty

self-employment program has also aided growth. Finally, one state inIndia, Andhra Pradesh, made the model their flagship strategy in ruraldevelopment resulting in various government agencies forming group.

7 Assuming 15 members per SHG and five members per family. NABARD estimatesthis number to be 100 million since they assume 20 members per SHG.8 Harper, Malcom, Why are commercial banks not entering the microfinance market? Paper presented at

Bankers Institute of Rural Development, Lucknow workshop, Kick-starting Microfinance, a Challenge

for the Indian Banks.http://www.alternative-finance.org.uk

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Currently, 750 NGOs and over 14,000 branches of 318 banks areassociated with the program. The program is still concentratedpredominantly in South India (73% of total SHGs and 82% of theamount lent) and, within South India, in the state of Andhra Pradesh(48% of total SHGs and 53 % of the amount lent). In addition to the

NABARD program, SHGs have received loans from other apex financialinstitutions, like Small Industries Development Bank of India (SIDBI)and Rashtriya Mahila Kosh (RMK), through NGOs and SHG federations,and from private financial institutions like Basix.

b) Other Models

Thrift cooperative is the other main membership-basedmicrofinance model in India. Thrift cooperatives have traditionally beenurban-based, formed typically among employees within anorganization. State or federal laws regulate these cooperatives, and

their performance often suffers due to excessive state control andpolitical interference. Two significant exceptions to the rule have beenthe cooperatives promoted by two organizations: CooperativeDevelopment Foundation (CDF) and Working Womens Federation(WWF).

CDF has promoted village level cooperatives that are fully ownedand managed by their members. These are governed by a newcooperative act that limits state control. There are 350 suchcooperatives in CDFs working area, and they cumulatively handledRs.137 million (US$2.91 million) at the end of 2000. The thrift

cooperative promoted by WWF, Indian Cooperative Network forWomen, has branches in the states of Tamil Nadu, Andhra Pradesh andKarnataka. The WWF cooperative had 98,184 members as of March2001, Rs.11 million in savings and a loan portfolio of Rs.54.75 million.

1.2 Federations

A federation is an association of primary organizations. Primaryorganizations may federate to realize economies of scale or to gainstrength as an interest group. Federations of cooperatives have a longhistory. Credit unions have federated at national, regional (e.g.

Association of Asian Confederation of Credit Unions ACCU) and global(e.g. World Council of Credit Unions WOCCU) levels. WOCCUrepresents 36,512 credit unions with a combined membership of 108million, and they have more than US$466 billion in savings andUS$371 billion in loans9. Among national federations, Desjardins ofCanada is among the best known. There are over five million members,in approximately 1,200 primary cooperatives, associated with

9 Website information, http://www.woccu.org

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Desjardins. These cooperatives are grouped into 11 federations thatare in turn members of a national confederation. As of December 1997,the primary cooperatives had US$54 billion in assets, and thefederations had an additional US$18 billion in assets.10 The federationsof village banks in Africa, mostly promoted by FINCA, are a well-known

case of federations in microfinance11

.

In India, cooperative banking and marketing societies arefederated at the district, state, and national levels. Excessive stateregulation in the cooperative sector in India, however, leaves hardlyany member control in these federations. Gujarat Cooperative MilkMarketing Federation (GCMMF), a federation of dairy cooperatives, isan exception. GCMMF is a three-tiered federation composed of 10,411village-level primary societies, 12 district-level federations, and astate-level confederation of the district federations. GCMMF producesthe AMUL brand of products, which generated US$493 million in sales

in 1999-00. The South Indian Federation of Fishermen Societies(SIFFS), in Kerala, is an example of well functioning federation ofprimary societies outside the regulated cooperative sector. SIFFS isalso a three-tiered federation with a similar structure to that ofGCMMF.12 In this case, the primary societies and the federations areregistered as charitable societies to circumscribe the regressive natureof the cooperative law.

1.3 SHG Federations

The primary difference between a SHG federation and other

federations is in the nature of the primary organization. The primaryorganizations in all the other cases of federations are formalorganizations that have body corporate status. By contrast, SHGs aresmall informal organizations. SHG federations were promoted byorganizations primarily as an exit strategy, i.e. to allow an organizationthat had founded SHGs to withdraw its support to SHGs while ensuringtheir sustainability.

Professional Assistance for Development Action (PRADAN) andMysore Resettlement and Development Agency (MYRADA), two largeNGOs that pioneered the concept of SHGs, were also the earliest

agencies to promote SHG federations. However, the model offederation promoted by the two differed significantly. PRADANpromoted Sri Padmavathy Abyudaya Sangam (SPMS), profiled in thisstudy, in 1992. Development of Humane Action (DHAN) Foundation, a

10 Basix, Desjardins: The cooperative movement of Quebec, Canada,http://www.basixindia.com/11 Eschborn, Renee Chao-Beroff, 1999, Self Reliant Village Banks, Mali (Case Study), CGAP, Washington

DC12 Website information, http://www.siffs.org

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spin off organization of PRADAN that took over PRADANs programs inSouth India, has since refined the SPMS model, and promoted 20 morefederations. It is currently promoting an additional 30 federations. Eachof the federation has more than 200 SHGs as members, and is aformally registered organization. These federations involve in financial

intermediation and employ paid staff.

Federations promoted by MYRADA are unregistered associationsof 15-25 SHGs each. These federations do not have paid staff and donot perform any financial intermediation. The MYRADA federationsprimarily focus on building solidarity, addressing delinquency anddealing with social issues. Some of the federations are starting to offeraudit services. A federation visited during the field study, for example,performed all these roles. This federation empowers the women in itsmember SHGs to agitate against illegal liquor sale in the village,identifies children for sponsorship support from MYRADA, and has

collected funds for a maternity ward for the local hospital. Thefederation has no permanent staff, office or funds, and the SHGs payRs.25 per month for its incidental expenses. MYRADA has promotedover 50 such SHG federations.

Apart from DHAN and MYRADA, another major attempt to scaleup the SHG federation model in India is UNDPs South Asia PovertyAlleviation Project (SAPAP). The project, started in 1994, has promotedSHGs and their federations in 20 mandals13 in three districts. TheSAPAP project is now being expanded to 180 mandals with the backingof the World Bank-supported District Poverty Initiatives Project (DPIP).

Other NGOs that have promoted SHG federations include SEWA inGujarat, PREM in Orissa, Chaitanya in Maharashtra, Gram Vikas inKarnataka, ASA in Tamil Nadu, and YCO in Andhra Pradesh14. Thestructure of the federations and the functions performed vary anddepend significantly on the promoting NGO. While many NGOs havepromoted federations, not many have replicated them on as large ascale as DHAN or MYRADA.

13Mandals are sub-district development unit unique to Andhra Pradesh. These aresmaller in geographical size and population than block, the development unit in allother states in India.14 FWWB, 1997, Indias emerging SHG Federations, Ahmedabad, India

Basix, PREM A case study, Unpublished paper, Hyderabad, India

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2.0 The Current Study: Methodology,Objectives And Scope

2.1 Methodology

The broad objective of the study is to explore the potential ofSHG federations to contribute to sustainability of SHGs. Since the focusis on federations, a thrift cooperative federation is also included in thestudy so as to give the study a comparative perspective. A two-stageselection was used to select the federations. First, organizations thathave promoted federations were identified on the basis of a literaturereview and the authors personal experience. From among theseorganizations, three organizations that have promoted a significantnumber of federations with the following characteristics were selected:the core activity is microfinance, and the federations are formalorganizations that have their own board, staff and funds. Once the

promoter organizations were selected, the specific federations weresuggested by the agencies, subject to the condition that they havebeen in existence for at least three years.15

In addition to the representatives of the federations and theirpromoter organizations, representatives of NABARD, commercial banks(ICICI Bank and Canara Bank) and other models of microfinance (Basix,WWF and MYRADA) were interviewed. The complete list oforganizations visited and individuals interviewed is presented inAppendix IV. The study was carried out over a period of three months,including three weeks of fieldwork in India

2.2 Specific Objectives

The specific objectives of the study were the following:

a) Identify the services provided by the selected federations,

15 Kudumbasree, a government program in Kerala that forms groups similar to SHGs(termed Neighborhood Groups (NHGs)) and their federations was originally includedin the study and visited as during fieldwork. However, the program was dropped inthe analysis stage, since the federations formed by this program focus more onchanneling government-subsidized credit to the poor rather than microfinance per se.

The program focuses on utilizing the subsidized poverty-lending program of thecommercial banks (a mandatory component of commercial banking in India),subsidized housing for urban poor, and training for self-employment. The interviewswith the leaders of the organizations visited revealed considerable success inimplementation: identifying and organizing the poor into groups, promotingfederations of the primary groups, encouraging the members to save in the groupsand, most significantly, eliminating corruption in accessing the subsidized loans fromthe banks. The weakness of the system is its focus on subsidized credit to thedetriment of savings and non-subsidized bank credit such as the SHG Bank Linkageand dependence on government grants for operational expenses of the federation.

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b) Analyze the benefits of federating,c) Assess the financial viability of the federations and estimate the

cost of promoting them,d) Identify the constraints involved in federating SHGs, ande) Recommend strategies to strengthen the federations.

2.3 The Selected Federations

a) Sri Padmavathy Mahila Abyudaya Sangam (SPMS)

SPMS is a federation of SHGs in the small temple town of Tirupatiin Andhra Pradesh. Tirupati is famous for being the city of the richesttemple in India, but, as most cities in India, has its share of poor, whopredominantly live in the slums. Most of the SHGs that are members

in SPMS are located in these slums. Promoted in 1992, it is perhaps theoldest SHG federation in India and one of the largest. DHAN Foundationcurrently supports SPMS by providing management professionals,strategic advice and support for resource mobilization.

b) Kurinji Vattara Kalanjiam (KVK)

KVK is a federation of SHGs near Madurai, a southern city in thestate of Tamil Nadu. The SHGs in the area were initiated in 1995 andthe federation was promoted in 1997. The SHGs in the federation arefrom an area that corresponds roughly to a Community Development

Block, the basic unit of development planning in India. KVK is typical ofthe federations with a nested structure promoted by DHANFoundation all SHGs in a block are federated into a block levelfederation (KVK) and SHGs in a cluster of villages form a ClusterDevelopment Association (CDA).

c) Sanghamitra Mandala Mahila Samakhya (SMMS)

SMMS is located in the Hindupur mandal of Anantpur district inAndhra Pradesh. SMMS is a federation of Village Organizations (VOs),which include all SHGs in a village as their members. Mandal is the unit

in Andhra Pradesh, equivalent to the Community Development Block,though significantly smaller. Anantpur is among the least developedregions in Andhra Pradesh. SHGs in the area were initiated in 1996,and the federation was started in1998. SMMS is supported by UNDPsSAPAP project.

d) Sri Viswabharthi Association of Women Thrift Cooperatives(SVAWTC)

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SVAWTC, formed in 1991, is a federation of thrift cooperatives inWarangal District of Andhra Pradesh. Compared with the other typesof federations analyzed in this paper, SVAWTC comprises a muchsmaller number of primary groups, but there are many more individual

members in each of the primary groups. Cooperative DevelopmentFoundation (CDF) supports SVAWTC.

In all the cases except SVAWTC, membership is restricted to thepoor, who are identified by Participatory Rural Appraisal (PRA)techniques.16 Though the membership of SVAWTC is not exclusivelypoor, the majority of members are poor. Given that landholdings are agood proxy of wealth in rural areas,17 it is worth noting that a CDFstudy on the member profile of SVAWTC in 1997 found 44% ofmembers to be landless and 22% to hold less than 2 acres. Theuniform thrift requirements, and loans being in proportion of thrift

(rather than total savings that may include other deposits), also makethe cooperative unattractive to the rich. The thrift amounts in mostcooperatives is low enough (Rs.20) for the poorest member to be ableto save.

More detail on the structure and systems of each of these federations can be found

in Appendix 2.

Table 1: Organizational Profiles of the FederationsIn US$

Particulars SPMS KVK SMMS SVAWTCClientele

Members 7272 3900 2699 4337Primary Groups 617 242 206 11

Average membership 12 16 13 394Savings

Savings 429,783 115,674 81,739 172,652Average Savings 59 30 30 40

Nominal Interest onsavings %

12 12 None 12

LoansExternal loans to date 675,130 514,130 25,283 NoneExternal grants for on

lending26,957 22,391 141,761 None

16 PRA techniques, which became popular in the early 1990s, are tools used to collect reliable information

regarding a village, street, etc. by a process of consultation with area residents, often in a group. The tools

are cost effective when compared to conventional survey methods.17 CDF, 1997, Member Participation rates in New Generation Thrift Cooperatives around Warangal Town

in Andhra Pradesh, Hyderabad, India

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Total credit generated 1,690,435

1,043,696 665,870 N.A.

Loan portfolio atprimary level

613,043 262,391 265,652 246,522

Loan portfolio at apex

level

434,348 206,304 106,739 50,870

Staff and InfrastructureFull time staff 10 32 10 12

Office Rented Rented Rented OwnN. A.: Not Available

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3.0 Services Offered By The Primary Groups AndFederations

Though the primary interest of this study is in the servicesoffered by federations, information on the services offered by the

primary groups is also presented to better understand the full range ofservices available to SHG members.

3.1 Primary Groups

SHGs and the thrift cooperatives primarily provide savings and loanfacility to their members. Savings is at the core of the SHG model andparticularly so for thrift cooperatives, as they do not receive externalfunds. Savings are retained in the SHGs and thrift cooperatives, andnot deposited with the federation or local banks. In the SHGs, savingsare compulsory but each member can save a different amount. In the

thrift cooperative, thrift (savings) is uniform, the amounts beingdecided during the annual general body meetings. In addition to thecompulsory savings/thrift, SHGs in KVK and SPMS, as well as the thriftcooperatives, offer other voluntary saving products, although thesehave not become very popular. The thrift cooperatives, and SHGs inKVK and SPMS, pay 12% as annual interest on all savings. SHGs inSMMS do not pay interest on savings. Members monthly savings rangefrom Rs.25 (US$0.53) to Rs.250 (US$5.30) per month.

The ability of the SHGs and thrift cooperatives to provide bothsmall and relatively large loans at the time of need, at costs lower thanthose available in the local market, and without collateral or excessivedocumentation attract the poor to these organizations. In KVK, SPMSand SVAWTC, interest rates on general loans range from 24% to 36%per annum, while in SMMS all loans have an annual interest rate of24%. Housing loans in KVK and SPMS are available tomembers at 15%to 18 %. KVK and SPMS also permit a member to have up to threeloans at the same time. In contrast, the other federations do notpermit members to have more than one active loan at a time. Loansrange from very small loans of Rs.100 (US$2.13) to large housing loansof Rs.40000 (US$851).

3.2 Cluster Development Associations And VillageOrganizations

CDAs provide a wide range of services, the primary one beingloans to SHGs. The apex federation is their principal source of funds,but they also have their own funds (equity from SHGs, grants fromNGO and accumulated profit). The other services include training new

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groups, accounts and auditing support, dissemination of information onnew programs (initiated by the apex federations) and support forgetting loans from banks. CDAs are also involved in promotion of newSHGs.

VOs have fewer resources than the CDAs and therefore provide asmaller range of services. They provide minimal general support toSHGs and some basic health care and livestock care through trainedvolunteers. The VO also provides a forum for all the SHGs in a villageto discuss common issues and interact with village leaders. Since theCDAs have their own staff, they also work more autonomously than theVOs.

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Table 2: Services Offered By SHGs And Thrift Cooperatives

Levels SPMS KVK SMMS SVAWTCSavings

Compulsory savings

Variableamounts,withdrawals only onmembershipcancellation

Variableamounts,withdrawals onlyonmembershipcancellation

Uniformamount,withdrawalsonly onmembershipcancellation

Uniformamount,withdrawalsonly onmembershipcancellation

VoluntarySavings

Products

Yes,withdrawal

onmaturity

Yes,withdraw

al onmaturity

None Yes,withdrawal

on maturity

NominalAnnualInterestRate

12% 12% None 12%

LoansNature Savings

linked,repeat andmultiple

Savingslinked,repeat andmultiple

Not linkedto savings,repeat butnot

multiple

Linked tothriftamount,repeat,

multipleloans linkedonly tovoluntarysavings

NominalAnnualInterestRate onmicrofinance loans

24 to 36 % 24 to 36 % 24% 24 to 36%

NominalAnnualInterestRate onHousingLoans

18% 15% No HousingLoans

No HousingLoans

Maturity Flexible, Flexible, Fixed 20 Fixed

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variablewithamountandpurpose.

Borrowergivesschedule,but withinlimits setby theSHGs.

variablewithamountandpurpose.

Borrowergivesschedule,but withinlimits setby theSHGs.

monthlyinstallments

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3.3 Apex Federations

One of the unique functions performed by KVK and SPMS (thatdifferentiates them from many other federations including thosestudied here, and those promoted by MYRADA) is the mobilization of

loan funds from commercial lending organizations. Both organizationshave received loans from national lending agencies (developmentbanks and housing banks). In SPMS, SHGs till recently could not receiveloans from banks, and external loan mobilization was therefore doneexclusively by SPMS. In contrast, KVK supplements SHG resourcessince the commercial banks are the primary source of external loanfunds. However, the recent introduction of housing loans (not yetdirectly available to SHGs) has significantly increased the proportion ofKVK funds in SHG liabilities. SMMS has not accessed loan funds butuses UNDP grant funds as capital to lend to SHGs (through VOs).SVAWTC does not receive loans from external lending agencies, but

has a small lending portfolio from the deposits that the thriftcooperatives make with the federation. Loans from the federationcontribute to only 20% of the total loan portfolio of the thriftcooperatives.

Insurance is another crucial service offered by the federations.KVK, SPMS and SVAWTC offer life insurance schemes. The federationsimplement some of these schemes independently, while offer others incollaboration with commercial insurance companies. KVK and SMMSalso offer cattle insurance for their members in cooperation withcommercial insurance companies.

The federations also offer non-financial services such aseducational support, livestock care and technical support for housing.SPMS recently started providing HIV counseling. KVK runs a trainingcenter on handicraft production and computer software. KVK and SPMSprovide technical support for house construction and purchase ofmaterials (both employ technical personnel for this). SPMS operates ahousing material production unit, which produces low cost constructionmaterials.

Though the services provided by the federations to SHG

members complement those provided by the primary groups, morecrucial are the services provided to the SHGs. These includeaccounting support and auditing, monitoring and co-ordination, conflictresolution, and training services. Monitoring is central to improving theperformance of SHGs, especially lowering default rates. Training forSHG members, leaders, and staff includes both formal classroomtraining and exposure visits to other well-functioning SHGs. KVK andSPMS have exclusive staff for all these areas. The benefits of the roles

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performed by federations are discussed in the next section. Moredetails on the functions performed by federations can be found inAppendix 2.

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4.0 WhyFederate SHGs

The primary purpose of federating SHGs is to ensure theirsustainability. Though the SHG model of microfinance has beensignificantly successful in terms of its outreach, resource generation,

and use of funds, SHGs are unlikely to be sustainable if they are notfederated. In the absence of federations, both formation and most ofthe maintenance costs of SHGs have to be permanently borne by thepromoter organizations, rendering the system inherentlyunsustainable. SHG federations not only ensure that SHGs bear alltheir maintenance costs but also absorb part of the costs of promotingnew SHGs.

Sustainability though, is not just an issue of cost coverage.Federations help SHG members to see SHGs as part of a largerorganization. They provide a sense of solidarity among members of

different SHGs in an area, and helps build membership stake in theSHGs. Creating a sense of ownership is important since SHGs are notself-promoted organizations, and the small size of SHGs makes itdifficult for their members to visualize them as sustainableorganizations. This section discusses specific factors that enable SHGfederations to contribute to SHG sustainability.

4.1 Economies Of Scale

SHGs require many maintenance services that can neither beprovided for by individual SHGs themselves nor are available on the

market at a scale needed by the SHGs. Many of these services areinitially provided by the organizations that form the SHGs, but this isnot sustainable since the SHGs rarely pay for the services, and alsosince providing maintenance services is not the core competency ofthe promoter organizations. Federations make permanent availabilityof these services more likely as it provides the necessary scale atwhich the services can be offered, and the possibility of it beingcustom designed to suit the requirements of the SHGs. Audit is onesuch service that is provided by all federations studied here. Evenwhen external auditors audit SHG accounts, federations help SHGsprepare for the process.

Capacity building is another service that SHGs cannot provideinternally. All the SHG federations studied provide capacity buildingservices to their member SHGs. This involves training the SHGmembers, leaders, and staff. By providing a common forum for reviewof SHG performance and enabling them to plan for furtherdevelopment, federations also create space for internal learning.

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Finally, federations provide a means to resolve conflicts. Suchconflicts are both internal (between members) and external (with otherSHGs in the village, the federation or outsiders such as the villageleaders and the banks). Federations help in resolving such conflicts bymaking available leaders and staff acceptable to both sides of the

conflict to play the mediator role. In some cases, the federation leadersand staff strengthen the negotiating position of the SHGs when theconflict is with outsiders.

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4.2 Reduction In Transaction Costs

The main innovation of SHGs was in reducing the costs thatbanks incur when lending to the poor. This was primarily achievedsince SHGs consolidate what could potentially have been 15-20

individual accounts into one single SHG account. Even on a peraccount basis, a NABARD study found the costs of lending to SHGs tobe less than that of lending directly to individuals. The transactioncost on a SHG loan account was 35.6% less than that of a generalpriority sector loan account on a first loan and 55.7% less on a secondloan18.

Apart from reduction of paperwork because of accountconsolidation, cost reduction is made possible because theorganizations that form and support the SHGs bears a high proportionof the monitoring costs. Though the banks are expected to make

periodic visits to the SHGs, and lend to them based on factors such asthe quality of accounts, regularity of meetings and credit history (forrepeat loans), the reputation of the promotional agency plays asignificant role in the bankers decision. The bankers substitute thereputation of the promoter organization for part of the task ofassessment and monitoring. The social collateral that the promoterorganization provides is insufficient, however, when the number ofSHGs increases and when amounts being lent to individual SHGsincrease, as these conditions necessitate closer scrutiny. When theSHGs are federated, the federations fulfill this role better as they arenearer to SHGs, and thus have better information on their

performance.

While banks lending to SHGs and their federations seem to bebenefiting from lower transaction costs, this is not reflected in areduction in interest rates, even after the banks were permitted to settheir own interest rates on SHG lending. In contrast, the insurancecompanies offering insurance products to the federations are able tooffer discounted premiums that reflect the lower transaction costs. Thelower transaction costs arise from the federations diminishing theprobability of fraudulent claims, and they making it possible for thecompanies to reach clients who have never previously insured

themselves or their assets.

4.3 Reduction In Defaults Rates

Through better monitoring and the provision of both positive andpunitive incentives, federations reduce default rates at all levels frommembers to SHGs, and SHGs to banks. Federation leaders and staff

18 Puhazhendhi.V, 2000, Evaluation Study of Self Help Groups, NABARD, Mumbai.

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interfere on behalf of SHGs when a member consistently defaults onher loans to the SHG. In the case of SHG loans from banks, the banksshare information with the federation on a periodic basis, and thefederation follows up any defaults immediately. Availability of loansand other services from the federation, the peer pressure from other

SHGs, and social prestige associated with SHGs having goodrepayment record are incentives for SHGs to maintain timely loanrepayment performance.

In the case of KVK, the trust between the federation and the localbranch of Canara Bank is such that the manager is willing to extendany number of loans to the SHGs if the federation can vouch for theirperformance. The staff of a bank lending to SHGs in SPMS alsoexpressed a similar level of trust. This trust comes from the federationensuring that SHGs maintains an excellent repayment record with thebank. In the long run, reduced transaction costs and timely loan

repayments should have a positive impact on the interest rates onloans to SHGs.

4.4 Providing Value-Added Services

Micro-insurance services are the main value added serviceprovided by three of the four federations studied. Federations providethese services either on their own or in collaboration with insurancecompanies. These services are valuable since the insurance companieseither have little reach in the populations being served by thefederations or do not have products suitable to the needs of the poor.

The information advantage of a member owned entity, and anestablished financial system, allows the federations to provideinsurance services in spite of the relatively small number of clients.

At present, the federations offer only minimal education, healthand livestock support services. The quality and quantity of services canincrease along with federation resources and their capacity to managethese programs. In view of the inadequate provisions of all theseservices for the poor, especially in rural areas where market optionsare not available, there is a great potential for the federations toprovide these services on a cost basis or in collaboration with the

government agencies that currently provide them. Two services thatsignificantly improve the lives of the poor that the federations couldplay a role in providing effectively are the supply of essential foodcommodities (currently provided by Fair Price Shops run in a highlyinefficient manner by government-controlled cooperatives), and childcare services for preschool children (currently provided directly by thestate). The federations could also play a role include the supply of

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agricultural inputs and marketing of produce in places where privatemarket organizations are absent or weak.

Over time, SHG federations have the potential to becomecommunity-based development organizations that play a significant

role in development of not just their members but communities as awhole.19

4.5 Increasing Outreach And Reduction Of Promotional Cost

The federations studied employ some of their revenue and stafftime in the promotion of new groups. The federation and primarygroup leaders also volunteer time for forming and grooming newgroups. It was observed that in all the federations studied, thefederation leaders perceived promotional activity as one of their keyresponsibilities. Furthermore, group formation by federations is faster

than that by NGOs because federations possess better localinformation and have greater legitimacy in the eyes of local residentsdue to their being based in the community. The staff and leaders of thefederations are able to identify the poor and persuade them to formgroups more quickly than outsiders.

Increasing outreach also contributes to the viability of thefederations by helping them to increase their membership to levelsnecessary to maximize economies of scale. The involvement offederations in promoting new SHGs also contributes to sustainability ofSHG based microfinance on a macro level as it reduces the overall

promotional investment needed for reaching all the poor in thecountry.

4.6 Empowerment

SHG federations require human resources of much highercapacity than that required by individual SHGs because of the variety

19There are two types of organizations in the United States that suggest a potentialfuture scenario for the SHG federations: Community Development Corporations(CDCs) and Community Development Credit Unions (CDCUs). There are more than

5,000 CDCs in the United States that provide a range of services to impoverishedcommunities. These organizations receive funding from both private and publicsources. CDCUs, of which there are more than 1,500, focus on communitydevelopment activities in addition to the traditional roles performed by credit unions.

Though CDCs and CDCUs are not federations, the size of the community served by anSHG federation is similar to those served by many of these organizations.http://www.ncua.gov/news/cdcu/cdcufact.html

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of tasks involved. The members in the governing bodies of the apexfederations build on the organizational experience they have gained inthe secondary organizations and SHGs, and also gain from morefocused capacity building efforts the promotional agencies are able toundertake at the level of apex federations. Thus, the

organizational/managerial capacities of individuals who take upgovernance positions in the federations develop more than if theystayed in the SHG, an improvement in human capital adds value to thecommunity capacity. In addition, skills and knowledge gained by thelocal youths recruited as staff of the federations also increase the totalhuman capital available in the community.

Federations also increase empowerment beyond that achievedby SHGs. While SHGs provide an opportunity for the poor to organizeand realize many of their capabilities, federations produce a newgeneration of leaders. Federation leaders also gain the respect of the

larger community that includes the non-poor because of the scale ofthe organizations they lead. Further, since a federation operates at alevel that also has other mainstream organizations, it createsopportunities for the federation leaders to deal with the powerstructures at these levels, leading to a higher level of empowermentthan that achieved by SHGs.

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5.0 Financial Analysis

5.1 Financial Viability

Analyzing financial viability is straightforward in the case of

conventional MFOs that lend to individuals. Even in the case of MFOssuch as Grameen Bank that use joint liability groups, loans are made toindividuals, and the primary income for the MFO is the interest onloans paid by the borrowers. In the case of SHG federations, however,SHGs do the primary lending, and therefore receive interest and otherfee payments. The SHG federations are either not involved in anyfinancial activity or, if involved, as in the case of the SHG federationsstudied here, lend to SHGs rather than to the ultimate borrowers. Thecase of thrift cooperative federations is similar - thrift cooperativeslend to individuals and the federation, if it does lend, lends to themember cooperatives. Hence, in the case of such federations, financial

viability must be analyzed at both primary and federation levels.

Financial viability analysis in this study has been done for twoSHG federations. For the analysis at the SHG level, the consolidatedincome and expenses of all SHGs is used. The federation costs areadded to the SHG costs in this analysis, on the premise that thefederation is required for the sustainability of the SHGs, and sincefederations are membership organizations, SHGs should have sufficientincome to meet the costs of their federation. This approach, while notrevealing if individual SHGs are profitable, indicates if all the SHGstogether have adequate income to bear all their costs. In contrast, the

federation level analysis estimates the adequacy of the federationsactual income to meet its costs. For the federation level analysis, onlyoperational self-sufficiency is calculated, whereas for the SHG levelanalysis, both operational self-sufficiency and financial self-sufficiencyis computed.20

Operational costs for the SHG level analysis includes alladministrative costs of SHGs and the federation, and financial costssuch as interest to be paid on loans and savings deposits. Theadministrative costs for the federation includes costs subsidized by the

20The CGAP definitions are as follows:a) Operational Self Sufficiency (OSS) = Operational Income / (Operational

Expenses +Financial Expenses)b) Financial Self Sufficiency (FSS) = Operational Income / (Operational Expenses

+Financial Expenses + Adjustments for subsidies and inflation)While CGAP includes in kind personnel costs incurred by promotional agency inAdjustments, in this study it is included in Operational Expenses itself, since bydoing so the OSS ratio reflect operational subsidy involved and FSS ratio, thefinancial subsidy.

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promoter organization, both in terms of direct transfers and cost ofpersonnel on seconded to the federations. Operational income includesinterest and fee income SHGs receive from their members, and doesnot include income such as penalties payments from members orgrants from promoter organizations. For the federation level analysis,

operational costs included administrative costs of the federation bothincurred by the federation and provided by promoter organizations,and operational income includes only interest income from the SHGs.In the case of KVK that has two levels of federations, costs of bothfederations are added, whereas income to the CDAs is taken asincome.

For financial self-sufficiency analysis, adjustments are made forinflation and the opportunity cost of funds. The national annualinflation rate is used to calculate the change in general reserves, whichis then added to the expenses. Overdue loans are not treated as losses

(and added to expenses), since information on overdue categorizedaccording to age was not available. However, both federationsmaintain a loan loss reserve at the SHG level that is created from a fee(1% of loan amounts), collected from members who take loans. Thelending rate (15%) to SHGs of a private MFO operating on a for-profitbasis (Basix) was used as the opportunity cost. This rate is higher thanthe lending rate of Bank of Madura, another private bank that lends toSHGs.21

Some loans, however, were not adjusted to the opportunity cost.KVK and SPMS have received housing loans from Housing

Development Finance Corporation (HDFC) and Housing and UrbanDevelopment Corporation (HUDCO) at below market cost. The lendingagencies impose a cap on the interest rate that can be charged to theultimate borrowers. In these cases, if the federations had obtainedthese loans at a higher cost, the lending rate to members would alsobe higher. The demand for the loans would not have been affected asthe SHG members are already getting loans for the same purpose fromother sources at rates higher than 24%. The analysis for SPMS at theSHG level has been done for one year only due to data limitations.

The complete analysis is presented in Appendix I.

Table 3: Profitability Analysis of the SHG Federations

Particulars 98-99 99-00 00-01 98-99 99-00 00-01

KVK SPMS

21 Bank of Madura was taken over by ICICI, a large private sector investment bank, in2001. Though Bank of Madura was losing money in its SHG portfolio, it attributed thisto the cost of promoting and supporting the SHGs.

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Operational Self Sufficiency

Federations

65% 63% 91% 89% 99% 108%

Operational Self Sufficiency

SHGs

112% 80% 91% n.a. n.a. 110%

Financial Self Sufficiency

-SHGs

106% 79% 90% n.a. n.a. 104%

Financial Self Sufficiency -

SHGs Sensitivity

(If inflation and cost of fundsincrease by 3%)

102% 75% 86% n.a. n.a. 98%

As can be seen from Table 3, the current operational self-sufficiency at the federation level is more than 90% for KVK, and morethan 100% for SPMS. The same pattern is observed for operational andfinancial self-sufficiency in both federations at the SHG level also. The

ratios are quite robust when subjected to sensitivity analysis. Theoperational self-sufficiency at the federation level has steadilyincreased during the last three years for SPMS. For KVK, it decreased in1999-00 relative to the previous year, and then improved in 2000-01.The same pattern is observed for KVK when the analysis was done atthe SHG level, both for operational self-sustainability and financial self-sufficiency. The management of KVK attributes the reduction in ratiosduring 1999-00to the sharp expansion of the federations activitiesduring that year. The marginal difference in percentages of operationaland financial self-sufficiency rates indicates a low level of subsidies, anotable feature, different from most MFOs.

The above analysis shows that SHG federations can achievefinancial viability. While SPMS has taken nine years to achievecomplete viability, KVK seems likely to achieve it in seven. DHANFoundation expects the federations currently being promoted toachieve full self-sufficiency in five years. DHAN attributes the decreasein time to the increased readiness of the financial institutions to lend toSHGs, and also improvements in the organizational systems of thefederations over time.

5.2 Cost Of Promotion

The costs of promoting SHGs and their federations are primarilytwofold. One is the direct cost of operational support: share ofoperational expenses of SHGs and SHG federations incurred by thepromoter agency. The indirect promotional cost includes theestablishment expenses of the promotional agency and salaryexpenses of their senior staff, whose services are available acrossfederations. Only the direct costs are used in the analysis done here,

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because they are likely to be the major proportion of costs and theobjective of the analysis is only to get an approximation of theresources needed.

Through March 2001, the DHAN Foundation incurred

approximately Rs. 1.57 million (US$ 33404) in direct costs in promotingKVK, including capital grants of Rs. 0.57 million (US$ 12128). DHANFoundation has stopped giving grant support for regular administrativeexpenses, but continues to bear the salary expenses of two of its staffworking with KVK, support that is to cease at the end of 2001-02. Thiswould add a maximum of Rs. 0.20 million to costs, taking the total costof promotion to Rs. 1.77million (US$ 37,659). This figure implies a costof around Rs. 7080 (US$ 151) per SHG (assuming 250 groups, currentlythere are 242 groups; the costs for previous years are not adjusted forinflation, and hence real costs are likely to be slightly higher than thisamount). Promotional cost of SPMS and SMMS could not be

determined, as the information for the initial years of the federation isnot available.

In a recent funding proposal, DHAN has projected totalpromotional expense of Rs. 2.3 million (US$ 48936) per federation (Rs.9200 per SHG) for support over a period of five years. This cost wouldcover the promotional costs required to promote 250 SHGs, 10 CDAsand an apex federation. The World Bank-supported Andhra PradeshDistrict Poverty Initiatives Project (APDPIP), the project that is scalingup the SMMS model of federations, envisages a budget of US$ 20.34million (US$ 113,000 per federation) to promote 180 Common Interest

Group (CIG) federations, that would promote 18, 000 CIGs and support20, 000 existing SHGs.22

Thus, taking a broad cost range of US$ 50000 to US$ 100,000per federation, an investment of US$ 200 to 400 million is needed topromote 4000 Federations (assuming 250 SHGs per federation) if theone million SHGs that NABARD plans to support through its SHG-BankLinkage program by 2008, are to be federated. NABARDs MicrofinanceDevelopment Fund, set up in 2001 to support promotional activities inthe microfinance sector (that includes a wide range of activities otherthan supporting SHG federations), has start-up capital of only Rs.1

billion (US$21.28 million). Though NABARD is seeking to increase thecapital available to the fund through contributions from commercial22World Bank, Project Appraisal Document, Andhra Pradesh District Poverty InitiativesProject, Washington DC, 2000. APDPIP uses the terminology CIGs to include commonactivity groups other than microfinance SHGs. The cost estimates given here referonly to the direct cost of promoting the CIGs andCIG federations.The cost of programadministration and other expenses are not included. This is done to make the datacomparable to the costs available from DHAN Foundation.

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banks, and private donors funds to NGOs involved in SHG promotionmay continue to be available, the projected quantum of funds neededjust for federating the SHGs indicates need for a significant increase inthe resources.

Innovative approaches have to be adopted to increase the poolof available resources. While conventional means of development aidin the form of grants from bilateral donor agencies and low interestloans from multilateral development banks can be a source of funds,policies to make more local funds available should be put in place. Onesuch policy can require commercial banks to invest part of their profitsto support MFOs such as SHG federations. Tax incentives can also beoffered to the commercial banks and other financial institutions for thesame purpose.

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6.0 Issues And Challenges: Internal

The previous section described the benefits of federating SHGsand indicated that federations can become financially viable if theinitial investment in promotional costs is made. The cost of promoting

KVK, typical of the federations that have been promoted by DHAN,further demonstrates that this investment is affordable. As wasmentioned earlier, however, cost coverage is just one of the factorsthat makes an organization sustainable. This section and SectionSeven discuss other factors that affect sustainability of SHGfederations.

6.1 Governance

Illiteracy and insufficient organizational experience constrain thegovernance capacity of federation board members. These constraints,

though inherent to being an organization of poor women - since bothpoverty and gender limit chances of being literate and involving inpublic activities, affects the ability of the governing body to effectivelyperform oversight functions. One example of this weakness was theinsufficient understanding of auditing expressed by the boardmembers interviewed; members perceived auditing more as a meansto check for accounting errors rather than as a check on management.

The promoter organizations are attempting to address this issueby investing in capacity building of the board members. But given theenormity of the challenge, capacity building needs to be supplemented

with other measures. Inviting educated and respected individuals inthe society to serve on the board (if needed, as non-voting members)and having advisory boards composed of such individuals are somemeasures that could be considered. The performance of elected boardmembers from the SHGs will also improve if they are on the board longenough to learn from experience. Too short tenures are a problem inone of the federations studied, where officeholders change every year.Giving board members (or at least the Chairpersons) sufficient financialcompensation to permit them to spend more time on federation-related duties would also improve the effectiveness of governance.

6.2 Staffing

In two of the SHG federations studied, chief executives of thefederations are also staff of the promoter organizations23. DHAN, the

23 The chief executive of SPMS is also the program leader of the DHAN Foundations Community Banking

Program. This case, however, is not typical of other federations. The typical federation chief executive,

though a DHAN staff, spends his/her time primarily on management of the federations. The day to day

management in SPMS is handled by a general manager who is also a DHAN staff.

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promoter agency in both cases, justifies this practice on the basis thatits federation model requires managerial staff of professional caliberthat federations, -being new organizations with limited social identityand resources would not be able to attract. SMMS has its ownemployee in the chief executive position, but for the new locations to

which the program is being expanded, SERP is recruiting universitygraduates on three-year contracts. These persons are expected topromote new SHGs and once federations are formed, take over as itschief executives. SERP also expects these individuals to becomeemployees of the federations at the end of this period. SERP justifiesits strategy in light of its plans to expand rapidly.

Though the skills required for effectively managing SHGfederations and the need to expand rapidly justify the strategiesadopted by DHAN and SERP, these strategies do affect thedevelopment of SHG federations as independent organizations. On one

hand, the chief executives of the federations have dual reportingrequirements to the federation board and the senior staff at thepromoter organization. On the other hand, the federation boards find itdifficult to set the agenda for their chief executives.

The ability of federations to hold the chief executivesaccountable does increase when federations start paying chiefexecutive salaries SPMS and other older federations promoted byDHAN already do this. In the case of SMMS, however, it was observedthat the board members felt inhibited in questioning the chiefexecutive though he is an SMMS staff and the federation pays his

salary. This inhibition arose since the current federation chiefexecutive has been involved all through the process of federationdevelopment, and hence, is perceived more as benevolent do-gooderthan as an employee. It follows that, even when the model ofseconding staff from promoter organization is followed, when thefederations are formed, new staff are deputed to take over as chiefexecutives rather than continue with the person involved in SHG andfederation promotion. Organizations promoting SHG federations shouldalso study the CDF strategy of not placing their staff in executivepositions in the thrift cooperative federations, though the cooperativefederations do perform limited functions compared to the SHG

federations.

6.3 Processes And Systems

Good systems provide efficient ways to carry out regularfunctions of an organization. The systems should be cost effective andeasy to use, while ensuring sufficient controls and efficiency. All thefederations studied need to improve their systems and processes. Risk

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management, repayment monitoring and financial management aresome of the systems to which the federations should pay increasedattention. Though delinquency does not seem to be a significantproblem in any of the federations, inability of the federations toproduce an accurate cumulative repayment performance for SHGs /

TCs is a weakness that needs to be addressed immediately. Soundprocesses contribute equally to effective organizations. Governingbody meetings, annual general body meeting and annual staffperformance review are some key organizational processes. Governingbodies and staff need to perceive the importance of these processes,although in some cases too much participation (such as participation ofall staff in the governing body meetings in SMMS) undermines thefunctionality of these processes.

Promotional agencies should also devote increased attention tothis area to improve the operational efficiency of the federations and

make the organizations sustainable. Development of quality systemsand processes would also facilitate replication. Regular system auditswithin the federations and adoption of best practices would hasten thedevelopment of sound organizational practice. The promotionalagencies should facilitate this process, and promote enhanced mutuallearning among the SHG federations so as to avoid duplication ofeffort. At the same time, processes and systems should be designed insuch a way that federations do not start micro-managing the affairs ofthe SHGs.

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6.4 Financial viability and accountability

Financial viability is a pre-requisite to a sustainable organization.The analysis in Section Five suggests that SHG federations can beviable if the initial promotional investment is made. In the long-term,

financial viability in a member-owned organization depends on abilityof the members to bear all costs without the external support. Thefinancial self-sufficiency ratio estimated in Section Five suggests thatthe SHGs in the two federations, for which the analysis was done, havethis capacity, or would soon have it.

While the bottom line is whether SHGs can pay for the servicesreceived from the federation, the accountability of the federation tothe SHGs is also influenced by how the SHGs pay for services. SHGfederations that earn income primarily from service charges or feesrather than as interest spread are likely to be more accountable to

their members. When SHG federations earn income primarily frominterest spread, SHGs tend to see the federation more as a lendingagency, and less as their federation. Furthermore, since federationsare not the primary source of funds for SHGs, dependence of SHGs onthe federation is bound to shrink as the SHGs own funds and theaccess to banks increases.

Recognizing the advantage of such a system, all federationspromoted by DHAN Foundation are shifting to such a system. The SHGspay service charges to the federation in proportion to their share incumulative loan portfolio of all SHGs. This system, on the one hand

forces the federation to justify their expenses to the SHGs, on theother hand, makes it clear to the SHGs that they need to bear the costsof the federation, if the services rendered are useful. SVAWTC has ineffect largely been always following such a system since it earns itsincome primarily from audit fees since lending to thrift cooperatives ismarginal in thrift cooperative federations.

6.5 Retaining Core Competency While Diversifying

Financial programs require very different management processesthan non-financial ones, a point that justifies the question of whether

microfinance services can and should be combined with other non-financial services. Nonetheless, the increasing recognition of the limitsto poverty reduction capacity of microfinance justifies MFOs providingother complementary services needed for poverty reduction.Furthermore, in a member-based organization, the successful provisionof microfinance naturally leads to a demand for other services. Allfederations in this study except SVAWTC provide non-financial servicesin addition to microfinance services. Under the new World Bank-funded

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DPIP project, which SERP would be implementing, the federationswould also channel resources for investment in communityinfrastructure.

While it is desirable that the SHG Federations take up new

activities that benefit their members, it might prove counter productivefor them to do so before they have evolved fully as microfinanceorganizations, and have sufficient resources and capacity (in terms ofboth governance and staff) to carry out these additional functions.There is also a danger that promoter agencys attention is diverted todeveloping the new functions before the SHGs and the federationssufficiently established. Hence, it is advisable that SHG federationsestablish their competency as Microfinance MFOs before diversifyinginto other activities.

7.0 Issues And Challenges: External

7.1 Stakeholder Perceptions On The Role And Capacity Of SHGs

Banks and governments are two crucial stakeholders of the SHG-based microfinance model. Despite the evidence of it being a profitablelending activity, most banks continue to perceive SHGs just as anothermeans to extend loans to the poor, i.e. primarily as a charitableactivity. Governments, as evidenced by the introduction of SGSYprogram and involvement of the District Rural Development Agenciesin SHG formation, perceive SHGs as an easily replicable mechanism forpoverty eradication.24 Unfortunately, neither the Banks nor thegovernment seems to perceive SHGs as micro-organizations that need

to become viable and sustainable if they are to play a significant role inpoverty reduction.

On the other hand, many of the NGOs involved in SHG promotionseem to believe that SHGs are sustainable even if they are notfederated, although this proposition seems unlikely based on theanalysis done for this study. These NGOs argue against federatingSHGs citing the possibility of federations leading to bureaucratization,

24 Swarnajayanti Gram Swarozgar Yojana (SGSY) replaces the Integrated RuralDevelopment Program (IRDP) and other poverty eradication programs. IRDP, the

largest anti-poverty program implemented in India, was in place for two decades. Theprogram, of which a major component was bank loans, had a disastrous averagerepayment rate of less than 40%. The major change in SGSY from that of IRDP is thata significant portion of the funds both loans and grants are to be made available toSHGs rather than individuals. SHGs are to be supported where they exist and newones promoted where they do not. But unlike the SHG-based microfinance program,SGSY is a subsidy-based program and lending by banks is mandatory. Furthermore,though SGSY envisages an increased role for Banks and NGOs, the program isprimarily administered by the District Rural Development Agencies, agencies thatlack the capacity to administer such a program.

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and loss of the advantages to SHGs in being informal, grassrootsgroups. That the detractors of federations fail to recognize the manybenefits derived from the model indicates a lack of awareness of therole of federations.

Thus, significant efforts are needed to focus the attention of allSHG stakeholders around viability and sustainability of SHGs. Furtherstudies on the utility of SHG federations and discussion among thestakeholders of study results can be a starting point of these efforts.

7.2 The Role Of NABARD

NABARD has played a crucial role in the development of SHGmicrofinance model through its promotional activities and refinancingactivities of the SHG-Bank Linkage program. But NABARD too has alsobeen slow to recognize the need for sustainability of SHGs. It has been

focusing, perhaps justifiably given the slow initial progress of theprogram, on increasing the outreach of SHGs and strengthening theirlinkage with the banking system. However, given the exponentialincrease in the program in the last two years and similar trendsobserved in other microfinance programs around the world, its growthcan be expected to be rapid in the coming years.25 The focus thenwould have to shift on sustainability rather than outreach.Interestingly, both the Task Force on Microfinance, and NABARDsprojections, envisage approximately 2000 federations in the process ofthe SHG-Bank Linkage program reaching one million SHGs by 2008.26

Nonetheless, NABARD is yet to take a pro-active role in the promotion

of SHG federations.

NABARD needs to shift from exclusively focusing on outreachand refinancing, to ensuring the sustainability of the SHG model.Measures NABARD may consider to strengthen the federations, as partof these efforts, are:

a) Creation of a database of SHGs and SHG federations,b) Facilitation of mutual learning among the promoter agencies and

federations by funding workshops and study visits to thefederations,

c) Funding for capacity building and training of federation staff andboard members, and

25 World Bank, 2001, Microfinance in India: Issues, Constraints, and Potential forSustainable Growth, Washington, DC. The study notes the similarity between thegrowth trend of the SHG-Bank Linkage program and outreach of the Grameen Bank.26

RBI, 1999, Task force on supportive policy and regulatory framework formicrofinance in India, Mumbai, India

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d) Commission process documentation and independentassessments of the different federation models.

7.3 Capacity Of Promotional Agencies

Documents

Federation Report Final Draft